An Illustration on How Hames Company Applies Equity Method to its Investments in Associates
The following transactions are those of Hames Company for the year 2010 pertaining to its equity investment in Vanch Company, an affiliate:
Purchased 25,000 at $150 per share of Vanch's ordinary shares representing 25% of the voting rights in Vanch. The net assets of the Vanch on this date have carrying value of $14,000,000
Utilizing the equity method of accounting for investments, Miss Vanuela creates an account Investment in Associate with the amount of $3.750,000, decreasing the cash account of the same amount, $3,750,000.
Sometime during the year, Hames Company receives cash dividends of $10 per share from Vanch. Cash is increased by $250,000 (25,000 units of shares multiplied by $10) and a corresponding decrease in the Investment In Associate of $250,000.
Note: When an affiliate company declares a dividend and the investing company receives its share, the investment account is decreased.
At the end of the year, when Vanch Company reports a net income of $2,000,000, Hames receives its share of $500,000, or $2,000,000 mulitplied by 25%.
As a result of this transaction, Investment in Affiliate account increases by $30,000. A new account called Income from Associate is created with the same amount of $30,000.
The carrying amount of the identifiable assets equals their fair values, except for land which has fair value in excess of the carrying amount of $200,000 and the building which has fair value in excess of carrying amount of $400,000. The building, on January 1, 2010, has an estimated useful life of 10 years. There is no indication of impairment of goodwill.
Because of this transaction, the "Income from Associate" and the "Investment from Associate" accounts decreases with the same amount, $150,000, computed below:
Cost of investment $3,750,000
Underlying equity in carrying value of net assets 25% of $18,000,000 $3,500,000
Excess of Cost $250,000
Attributable to land 25% of $200,000 ($50,000)
Attributable to building 25% of $400,000 ($100,000)
Applicable depreciation on building is $10,000 - $100,000 / 10 years.
There is no adjustment applicable to land, even if its fair value differs from its carrying amount in the books of Vanch because land is not subject to depreciation or amortization. Neither is there any adjustment on the goodwill, as goodwill is not impaired. If goodwill is evaluated to be impaired, a proportionate share in impairment loss should be taken up by Hames by debiting income from associate and crediting the investment account.
On the face of the balance sheet, the Investment in Associate account should be shown in a separate line presentation as required by standard in presenting the financial statements. Likewise, Income from Associate account shall be presented as a separate line item on the face of the income statement. The investment in associate is valued on the balance sheet at its carrying amount under the non-current asset classifcation.
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